I am a senior editor at Forbes, covering legal affairs, corporate finance, macroeconomics and the occasional sailing story. I was the Southwest Bureau manager for Forbes in Houston from 1999 to 2003, when I returned home to Connecticut for a Knight fellowship at Yale Law School. Before that I worked for Bloomberg Business News in Houston and the late, great Dallas Times Herald and Houston Post. While I am a Chartered Financial Analyst and have a year of law school under my belt, most of what I know about financial journalism, I learned in Texas.

Court Rejects $14 Million Fee For Lawyers, $3 Million For Their Clients

The Third Circuit Court of Appeals today threw out a class-action settlement that would have paid the lawyers who negotiated it more than four times as much as their clients.

The 34-page decision also addresses the practice of cy pres, in which lawyers arrange to give money to charities when they can’t distribute enough of the settlement proceeds to the class.

The practice is of dubious legal provenance and can exacerbate the already serious conflicts between class-action lawyers and their ostensible clients. As the Third Circuit noted, including gifts to charities unrelated to the litigation “may increase a settlement fund, and with it attorneys’ fees, without increasing the direct benefit to the class.”

In this case, law firms including class-action specialists Hagens Berman and Wolf Haldenstein sued Babys ‘R’ Us and and manufacturers like Baby Bjorn AB for allegedly setting “price floors” for certain products. In the settlement, the defendants agreed to pay 20% refunds to customers who could provide a receipt and $5 to customers who couldn’t. The judge approved $14 million in fees and expenses based on the $35.5 million settlement — already a hefty 39% of the pie — but soon it became clear only $3 million in claims would be paid. No problem, the lawyers said: The rest can go to charity.

Attorneys with Ted Frank’s Center for Class Action Fairness sued to block the settlement, saying the fee was excessive given the small amount of money going to the lawyers’ clients.

The Third Circuit agreed in a decision that appears to set stricter new rules for class actions in its district even while upholding the utility of the mechanism. It acknowledged the “potential for conflict” between lawyers primarily interested in a fee and their clients, who are primarily interested in winning money.

“We confirm that courts need to consider the level of direct benefit provided to the class in calculating attorneys’ fees,” the appeals court said.

The court also seemed to be calling on judges to demand more information about settlement procedures before approving fees, or even withholding approval of fees until the claims have been administered. Cy pres is an acceptable alternative to paying money to people actually involved in the case, the court said, but the amount given to unrelated charities should serve to reduce the pot used to calculate fees.

In this case, the appeals judges said, the lower court approved the fees without knowing the relatively tiny payout to class members. Plaintiff lawyers “did not provide this information to the Court, preventing it from properly assessing whether the settlement was in the best interest of the class as a whole.”

But the appeals court avoided attacking the class-action process directly, celebrating its “deterrent effect” — don’t judges understand that most settlements are paid out of insurance? — and rejecting the idea that judges should reject settlements where the lawyers earn more than their clients. (Note: An attorney subsequently sent me this article detailing how some antitrust claims, like intentional torts and criminal fraud, may not be covered by insurance.)

Courts shouldn’t “discourage counsel from filing class actions in cases where few claims are likely to be made but the deterrent effect of the class action is equally valuable,” the court said.

The court didn’t address the biggest question in cy pres, which is whether it is constitutional for judges to give money to an entity that never had a “case or controversy” before the court. Neither did it address the potential for mischief as lawyers decide who to give the money to — a university their children are applying to, perhaps? Or a charity that just happens to hold the most exclusive holiday ball in town?

In this case we may never know since the Third Circuit sent it back for review before the recipients were named.

Post Your Comment

Post Your Reply

Forbes writers have the ability to call out member comments they find particularly interesting. Called-out comments are highlighted across the Forbes network. You'll be notified if your comment is called out.